Ronald is Professor of Strategy at the Frankfurt School of Finance and Management in Germany.
When he takes a break on Forbes, you can continue to follow his writing on innovation strategy at http://tinyurl.com/Klingebiel

Too-Big-To-Innovate Is Not About Innovation

On a recent BBC World Service program, I was fortunate enough to chat with Bob Collymore of mobile and payment firm Safaricom, and venture capitalist Simon Cook of DFJ Esprit, about the problem established firms seem to have with adapting to market changes. We were in agreement, albeit for different reasons.

Whether applied to Microsoft, Facebook, or Apple, the too-big-to-innovate thesis typically focuses on the complex bureaucracy and short-term share-price orientation that come with success, conspiring to make big firms miss the next big thing. Microsoft’s embrace of Skype, Facebook’s digestion of WhatsApp, and Apple’s purchase of Dr Dre, are often cited to prove that the tech giants have lost their ability to create big innovations internally.

But the picture is more complicated. Big firms do innovate, intensively and incessantly. Their R&D departments unleash untold resources. Google may be notorious for financing experiments in anything from software to self-driving cars but even old-school incumbents like Volkswagen are at it. The number three automaker said it would invest a whopping $84B over the next five years. By comparison, a much smaller challenger, Tesla, invested $0.2B in 2013.

Given their financial heft, corporations tend to attract some of the brightest minds. So it is no surprise that studies find firm size to be a significant predictor of innovation. Those who suspect that this is mostly due to bread-and-butter innovation, rather than the more daring kind, should consider the fact that history is also littered with big inventions by big firms: the graphical user interface originated at Xerox, the digital camera at Kodak, and the smartphone at Nokia. GM pioneered electric cars decades ago and Microsoft showcased smarthome ideas back in the 1990s. I could go on.

So, innovativeness is not the problem. Resource allocation is, however. None of the above examples made it through the firms’ decision gates. You may recall that Apple popularized the GUI, not Xerox. Kodak (and Polaroid) abandoned their digicam efforts, losing out to Asian challengers. And Nokia did not manage to dominate smartphones either. Toyota stole a march on GM in hybrids, and the smarthome territory will probably go to the likes of Google, with Microsoft lagging behind.

How come big players drop the ball somewhere between the lab and the storefront? Given that established firms’ innovation engines generate lots of ideas, decision makers must choose where to allocate scarce resources. If the choice is between allocating resources to a tame project promising a guaranteed 3% return and a radical project promising vast fortunes, massive failure, or anything in between, decision makers tend to plump for the safer option. This is a tendency common to many, but since only large companies are actually spoilt for choice, it is here that the phenomenon is being documented most, for example by Clayton Christensen.

Was that really not going to work? (CC credit: Stephen Edmondson)

Many more innovations fail than succeed, so caution is understandable and, in fact, required. But since product development and refinement can take years, a decision not to proceed might leave the field wide open to competitors. And that decision is based on very limited information. Therefore, the chance of making a decision error is high (especially for established firms set in their ways). By the time it becomes clearer that an idea is going to fly, it is often too late to start development. Competitors will capture the market first.

A recent Globe and Mail article about Blackberry’s belated pivot towards smartphones nicely illustrates how hard it is to make up for lost time. The handset maker had experimented with capacitive touchscreens, modern operating systems, and device-agnostic software as early as 2006 but aborted each of these efforts prematurely, only to be then caught out by feisty entrants that are dominating the market with such offerings today.

The closer to launch an innovation is, the easier it is to gauge its commercial viability. In the example of another handset manufacturer I have worked with, project business cases estimated 12 months prior to launch were off by a factor of 2.5 (either way) on average, with some being wrong by an order of magnitude. Three months before launch, the firm typically misestimated by no more than 60% either way. Not perfect but a lot better. Making a final project selection at that stage promised a much better success rate: fewer misses and more hits.

If you add to this the insight that development costs ramp up over time and are low initially, there is a case for keeping project options open while they are still affordable. That way technical uncertainty can be eliminated and market forecasts become more accurate, without betting the company and without losing time on competitors. Samsung Mobile is an extreme example of this: it let just about every innovative flower bloom initially and thus was one of the few to make it through the transition from feature-phones to smartphones.

More such flexibility does not mean that project options should be allowed to proliferate unchecked. Without effective mechanisms to abort projects, resources will be wasted. Failing to monitor options hurts performance just as much as not having any. Motorola’s Iridium satellite project, for example, was a bold idea with massive potential, judging by what one could glean of the future telecoms market in the 90s. But over the eleven years of development, it became increasingly clear that terrestrial mobile communication would win the day. The lack of means to stop the satellite project led to one of the biggest write-downs ever. Optionality will have to be managed ruthlessly to be efficient.

Smaller startups don’t have to worry about their flexibility. Often they do not even have a formalized resource-allocation process yet. They tend to have one big idea and no choice but to make it work. When it doesn’t, which is often, we never get to hear about it (venture capitalists like Mr. Cook quietly take the blow). But when it does work, we are in awe of their innovation prowess, and wonder why the incumbents did not come up with the same idea themselves. Chances are they did, possibly even before the startup, but they probably killed the idea prematurely. In all likelihood, the newly successful startup will come to make the same resource allocation mistakes as it matures. Facebook grew on the back of a very successful innovation for desktop Internet but has been playing catch-up since IT went mobile.

Time to start changing the tone of the too-big-to-innovate debate and to tackle the real issue. It is not their innovation capability that holds large firms back. It is their resource allocation process. Better management of innovative options would alleviate the problem.

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